SEC v. NEW ENGLAND ELEC. SYSTEM

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Argument of Daniel M. Friedman

Chief Justice Earl Warren: Number 305, Securities and Exchange Commission versus New England Electric System et al.

Mr. Friedman.

Mr. Daniel M. Friedman: Mr. Chief Justice and may it please the Court.

This case is here on a writ of certiorari to the Court of Appeals for the First Circuit for the second time.

It involves the validity of an order of the Securities and Exchange Commission entered under Section 11(b)(1) of the Public Utility Holding Company Act, directing the respondent New England Electric System which with convenience I shall refer to as NEES, to divest itself of its gas properties.

The NEES is a registered holding company.

In Section 11(b)(1) of the statute, in general terms, restricts a holding company to a single integrated public utility system and it does, however, permit an exception if the Commission finds among other things that the additional system cannot be operated as an independent system without the loss of substantial economies that would occur if the additional system is retained in the holding company system.

This is a Clause A of 11(b)(1) which is the subject of this litigation.

Now, when the case was here before, the question was the interpretation of that clause, the meaning of the phrase, loss of substantial economies.

The Court of Appeals had held that a loss of substantial economies was shown if the company proved a loss that would be considered substantial as a matter of a business judgment.

This Court reversed holding that the Court of Appeals have taken too narrow a view of the statute and it’s said that the appropriate interpretation of the statute which is that -- which is viewed the Commission consistently had upheld, that is as it put -- as the Commission has put it, the economy is so important as to cause a serious impairment of the additional system.

The question now before the Court is not the interpretation of that statute.

That was resolved the last time for the application of that statute.

That is, did the Securities and Exchange Commission here correctly hold that NEES had failed to carry its burden of proving that the divestment of its gas properties would entail the loss of substantial economy?

NEES has both an electric utility system and a gas utility system, and it has selected its electric system as its principal system to be retained.

The gas system has eight different, separate gas companies, all located in Massachusetts.

Its total plant is about $56 million.

Its gross revenues for the last year for which both at its figures were available 1958 were about $22 million and it serves 235,000 customers approximately.

Justice Byron R. White: This is the gas system.

Mr. Daniel M. Friedman: This is the gas system, the eight gas companies.

Now, about almost 80% of NEES’ gas customers are also served by one of the electric subsidiaries of NEES and there is an over exchange -- the areas cover each other to the extent of 75%.

That is the service 75% of the area in which the gas companies have their franchise.

It’s also an area where the electric companies have their franchise.

The gas companies are organized administratively as a gas division and it has a centralized management and operations.

The man who is the head of the gas division is also the president of each of the gas companies.

And he in turn reports directly to the Vice President for Management of NEES, and NEES is understandable in this kind of a situation.

It performs a large variety of services for both the gas and the electric systems.

And to support their claim that divestiture of the gas properties have result in the loss of substantial economies, NEES relied on a very elaborate study which purported to show in great detail, exactly how much more it would cost for every phase of the gas company’s operations if they were required to operate separately rather than jointly.

The study was prepared by a public utility consultant firm named Ebasco.

The study basically what Ebasco did in making the study is as follows.

First, they examined the gas system and attended to decide how it should appropriately be organized if each of the gas companies separately was divested from the electric system and you have eight separate gas companies operating.

They’re decided on the appropriate organization and then they attempted to say how many employees each of the gas companies would require for this operation.

Then they made a determination as to how much it would cost to run each of the gas properties separately.

That is if they discovered, they would need three clerks in the billing office, they would attempt to say precisely how much the clerk would have to be paid.

So it reached a composite figure, showing the total cost of operating all of the gas properties separately.

Then they determined how much more this would be than the present cost of operating the gas property separately by looking to the -- primarily to the allocation on the books of the NEES system as between the gas and the electric companies.

When services were performed and expenses were incurred by the NEES system, it allocated part to gas and part to electric.

They accepted in most instances these allocations, compare them and reached the figure showing the additional expenses, then and the only event that they make a further study building on this information to determine how much less the expenses would be if instead of the eight gas companies being operated as eight separate systems, they are operated as a single system.

And the end result of this lengthy analysis, this lengthy study which occupies three volumes is they concluded that upon divestiture of the gas properties as a single system, additional expenses of approximately one million and one hundred dollars would be incurred.

The Commission held two things.

The Commission held first that because of various deficiencies and defects in this study, it didn’t provide a reliable basis for establishing that there would be a loss of substantial economies and secondly it held that even if you accepted the figure projected by Ebasco that in the statutory sense would not constitute economies that would be substantial.

Now, I think it’s important in considering the Commission’s decision to just permit -- indicate precisely what this study is.

Its face, it seems to be very specific and very exact.

They go down each company, each particular function, dollars and cents, they add $28.00 here and they say, of course this in this particular function $109.00 less.

But basically, what this study is, is a series of a huge number of business judgments.

If you want to call on that, perhaps you might say informed guesses and they just do not have, it seems to the Commission, the kind of precision that this detailed analysis suggest.

It does not have that kind of specificity.

For example, it rest on a host of imponderable business decisions.

Justice Byron R. White: Could it be anything else?

Mr. Daniel M. Friedman: I don’t see how it could Mr. Justice when you try to find out how much more it would cost to operate.

Justice Byron R. White: I know but if you’re going to precede this kind of -- carry this burden of proving, you either going to do it this way or you won’t do it at all, I gather.

Mr. Daniel M. Friedman: Well there might -- there might be situations Mr. Justice.

You could prove it as I would come to it in a minute the thrust of my argument.

It is that this kind of a study -- this dollars and cents study basically is not -- does not prove loss of substantial economies in the sense that Congress used the term.

The basic test when we think the basic theory on which the Commission rejected in its basic floor is it -- does not look to experience, it does not look to see what has happened to comparable companies in the light of the statutory standard that the loss of substantial economies are economies so important to substantially impair the ability of the system.

We think the real focus here has to be, all these economies of the type, all these losses of the type which you can fairly say that there would be a substantial impairment of the ability of this system to stand alone if it’s not part for holding company.

Justice Abe Fortas: Mr. Friedman, is there any dispute as to the burden of proof that is to say, is there any contest to your submission as I’ve take it that NEES, New England Electric Services had a burden of proving that there would have been a loss of substantial economies?

Mr. Daniel M. Friedman: No, Mr. Justice, they can see that on page 12 of their brief that they have the affirmative duty of bringing themselves within this narrow exception.

Justice Abe Fortas: And First Circuit didn’t quarrel.

Mr. Daniel M. Friedman: No, they did not quarrel.

They -- the First Circuit in effect said that they didn’t think the Commission had adequately explained why it had rejected this.

Now, if may just point out on the judgment.

The point I make on the judgment fact Mr. Justice White is that the very nature of this thing, the very nature of this study renders it inherently a dubious study.

In other words, the dollar certainty that’s put on this, the one million one that says, this is not that certain, this is not a case where someone is trying to determine how much more it would cost if you put in a new generating plan.

Justice Byron R. White: But if they -- but if they proceed in another way, this other way would necessarily involve some inherent judgment also.

Mr. Daniel M. Friedman: It would Mr. Justice but it will --

Justice Byron R. White: What you’re just saying that -- if this is the defect that makes the defect, it would be pretty hard to get rid of that defect no matter how you precede.

Mr. Daniel M. Friedman: Well, I think Mr. Justice --

Justice Byron R. White: I don’t want to -- I don’t need to argue with you.

You better go ahead.

Mr. Daniel M. Friedman: Now, as I -- as indicated and I will come to it in a little more precision in the moment, the Commission found various defects in the study.

But I like to come to the point that I alluded a moment ago in answer to Justice White’s question that the basic flow here is that there was no attempt really on the part of the defendants to tie this particular claim of increased expenses to the ability of the gas system to operate efficiently on its own.

And not only was there no attempt to show that by this study but in fact the record shows and the Commission found that independent companies not under control with electric systems were able to operate successfully.

Now, there are two aspects of this which I would like to discuss.

The first thing deals with seven independent gas companies in Massachusetts.

All of which was smaller than NEES and I say independent in the sense that these companies were not under common control with an electric company that was serving the same area.

Now, this seems to us the relevant standard because the respondents have estimated that 80% of the additional expenses resulting from the divestiture were due to the separation of the joint -- the elimination of the joint operations of the electric and the gas system.

And it seems to us highly relevant that if other gas companies in the same area have been operating successfully without the benefits, the alleged benefits I may say of being part of an electric holding company system, this it seems to us pretty clearly indicates that the NEES system, larger than these other systems should never have no trouble doing the same thing.

And as the Commission put it at page 815 of the Appendix that’s this little brown volume as distinguished in the large record and the previous case.

They said they couldn’t accept this contention that NEES, the second largest gas system in Massachusetts would not be able to provide management and service comparable to that provided by other gas utilities in the state.

Now, the Commission also pointed out that the percentage ratios in this case, that is the ratio between the amount of alleged additional expenses in various operating figures deemed significant revenues, revenue deductions, gross and net income were either less in this case -- were less in this case or either less or not significantly higher than comparable percentages that in a number of previous cases in which divestiture had been ordered, the Commission held was not substantial in the statutory sense and they’ve set that out in a table at page 28 of the Appendix attached to the opinion.

And again, it seems to us by the same kind of reasoning if the losses involved on the divestiture of other systems were not significantly greater than this system that too undermines the claim that the increases here would seriously impair the ability of the gas system to operate.

Now, it seems to us that its -- this whole thing is not at all surprising because as we have set out in our brief, the legislative history of the Act, the original Federal Trade Commission Report upon which it was based.

The debates in Congress indicate that the Congress generally expected and anticipated that it would only be the small system that would be able to demonstrate that its separation from the holding company system would seriously impair its operating abilities.

The Congress was aware during the debates on the Public Utility Holding Company Act of the claims by the proponents of holding companies that they produce great benefits for the operating companies and that they were also aware naturally of the claim that terminating the holding company relationship between gas and electric properties would result in additional expenses.

But Congress in that statute made the value of judgment that any alleged benefits of the holding company were outweighed by the benefits to the public of breaking up these systems and eliminating the great evils that they have been shown to have and as the conference committee report on the Bill putted, the congress decide that it should be limited to a single system unless the holding company can show a real economic need on the part of the additional integrated system to be in the Holding Company Act.

Now, there is another aspect of the Commission’s decision.

The is the Commission in evaluating the claim that these additional expenses would result in the loss of substantial economies took account of the fact that there are off setting compensating benefits which in your two-way gas system when it is separated from an electric system in the same holding company and when this case was here before this Court recognized this significance of this fact.

The Court had pointed out -- the Court pointed out that one of the evils that have resulted from control of utilities by holding companies was the retention in one system of both gas and electric properties and the favoring of one of these competing forms of energy over the other.

The Court also recognized that the competitive advantages to be gained by a separation of gas and electric are difficult to forecast and it concluded that the evaluation of such benefits is a matter of Commission expertise on the total competitive situation.

Now, I think these statements by the Court have to be considered in the light of the argument.

The Commission argued the last time that the case was here that one reason for giving the statute the broad reading was because otherwise if you just had assessed a substantial business judgment, the economies that was substantial in that sense there was no room for the Commission to take into account these offsetting benefits.

But when the case came back to the Court of Appeals, the Court suggested that all that could be done on the matter of off setting benefits was to consider them in interpreting the statute but once you have interpreted the statute, the Commission could not take account of these offsetting benefits unless it was actually able to put a dollar and cents value on them.

In other words, I’ll tell you what the Court of Appeals are saying, the only way the Commission in determining whether a loss of substantial economies have been shown, the only way the Commission in deciding that question could take account of offsetting benefits was to put a value on it that the offsetting benefits of competition amount to $200,000.00, a $100,000.00 whatever the figure would be.

And I particularly invite the Court’s attention to page 45 of the joint appendix.

That was the first opinion which the Court of Appeals in its second opinion said it was readopting and say, it’s at the top of page 45, what we do question is the Commission’s failure to find or articulate any specific or approximate financial benefit that such a change would occasion.

This is in connection with its discussion of the offsetting benefits of competition.

Now, that seems to us robs the standard of any meaning because I don’t see how you can take a fact into account in determining what the statute means and then say you completely exclude it when you come to apply it and it seems to us, if this is a significant factor in interpreting the statute, it can only be given significance when you come to apply the statute.

Now, I would like to come briefly to some of the criticisms that the Court of Appeals made of the Commission’s treatment of this case.

We have said out in our brief and at greater length in our reply brief, a number of the defects that the Commission found in this study which in its view rendered it unreliable as a basis for predicting what the loss of economies would be and that is if I change it, what the additional expenses would be.

I walk -- them at the oral argument that some of them are quite detailed and quite complicated but I would like to explain that basically they’re related to a category of expenses known as treasury and customer accounting.

And this represented roughly 40% of the total additional expenses that Ebasco predicted would flow from the separation of the properties.

The Court of Appeals said that as I quote it, “We do not necessarily criticize the Commission for its skepticism in the specifics.”

I take it, that meant, they didn’t criticize the Commission for finding that there were some defects in the study but what it said was, the Commission was required not to reject the study because of these defects but to adjust it downward to find out how much less than the amount allegedly established was shown by the study and then to make a determination whether that lesser amount was substantial.

Now, the infirmities in this case were not just arithmetical errors, errors in the sense that perhaps they used the wrong figure for something.

They are we think basic errors in the methodology of the study and we think that where the study itself is subject to this deficiencies that the Commission was acting well within its authority in saying it could not accept the study at all as a basis for predicting the amount of additional expenses.

We don’t think the Commission was required to go through this study and after it had gone and found these defects then to go ahead and look at every single item and try to determine the value of the correctness of every particular additional little amount estimated.

That will be as an impossible burden on the Commission.

Now, the Court of Appeals in dealing with the second phase of the case, that is the Commission’s conclusion that even if you accepted for the sake of argument, the dollar expense estimate by the holding company that this would be not substantial, criticize the Commission on the ground that it had failed to address itself to what the impact of these additional expenses would be on the NEES gas properties.

It said that they just invoke ratios of other companies and these are irrelevant.

Well, in the first place, we think the burden basically was on the respondents to prove that the effect of these additional expenses would be substantially to impair the ability of the NEES system.

Furthermore, it seems as I have indicated that the effect of such increases in expenses on comparable companies, on companies which have shown their ability to operate without this “the crutch” of the holding company support is the clearest evidence that this particular company if it is turned lose from holding company control similarly would be able to stand alone and I think I -- that basically, the burden of proof is on the respondent and that the Commission here properly exercised this discretion and at full basis for concluding as it’s stated the end of its opinion at page 25 of the Appendix that it could not find on this record that the gas companies could not be soundly and economically operated independently of NEES and we think that the Court of Appeals when it told the Commission to take another look at this case that it had to answer a lot of detailed questions that the Commission was required to state in greater deal to explicate in great specificity the reasons for its decision that it put upon the Commission an impossible burden but it was asking the Commission to do things that we don’t think the Commission was required to do.

The burden was on the respondents.

The burden was on the respondents to show that they came within this narrow exception and we think the Commission was justified in concluding that on this kind of a showing they have not sustained that burden.

And I would like to reserve the balance of my time.

Chief Justice Earl Warren: Yes you may.

Mr. Quarles.

Argument of John R. Quarles

Mr. John R. Quarles: Mr. Chief Justice and may it please the Court.

I would like at the outset to make perfectly clear what the position of the respondents is with respect to the questions raised by this case.

We recognize that Section 11(b)(1) of the Holding Company Act as recently interpreted by this Court, reflects a general policy favoring the separation of alleged gas utilities that the exception to that is in intended to be a narrow exception that any holding company claiming to come within the exception has the burden of meeting astringent test and that that is a heavy burden.

We do not question the Commission’s wide experience, its expertise or its competence to evaluate the evidence.

Do not claim that the Commission has any duty to adduce any evidence or otherwise supply any deficiencies in the company’s case neither the respondents nor the court below suggested imposing any burden of proof on the Commission.

What we do claim is that the Commission with administrative agency power of life or death over a holding company system has a correspondingly heavy responsibility and duty to deal with each case separately on its own merits to evaluate the evidence by a fair appraisal of the evidence in the light of its expertise and experience but not to substitute its expertise for the evidence.

We feel that in this case the gravity of the Commission’s responsibility is emphasized by the finality of the action in requiring a divestment.

If in a doubtful case, judgment is suspended.

The Commission retains jurisdiction and counted anytime reopen the case, their people begin to appear.

But if divestment is required and it later turns out to have been a mistake, there is no way of correcting it.

Once that step is taken, the damage is done and the losses are irretrievable. In our view, the basic question here is whether or not the Commission has properly discharge this heavy responsibility, the Court of Appeals after a review of the entire record concluded that it had not.

Careful reading of the findings and opinion in this case as distinguished from ex post facto explanations of what the Commission intended or said, strongly suggest that what happened here was that on a preliminary inspection of the figures, the Commission or its staff observed a superficial similarity between the losses shown by the Ebasco report and losses claimed but not established in prior cases in which divestment had been ordered and jump to the conclusion that those were another case falling in the same category and controlled by pressman.

Justice Abe Fortas: I’m not sure I understand that Mr. Quarles, do you mean that the Commission had before it the record performance in other cases in which gas properties had been divorced from electrical properties and in which there had been a better record of performance than the Ebasco report came out with in this particular case?

Mr. John R. Quarles: If there was a record of the performance subsequent to divestment of any companies that had been separated or it does not appear in this record and is not referred to in these findings and opinion.

Justice Abe Fortas: I thought that should –

Mr. John R. Quarles: The comparison.

Excuse me sir.

Justice Abe Fortas: I beg your pardon.

I thought that’s what you were saying that the Commission did rely on superior performance in other cases that’s what you said.

Mr. John R. Quarles: No sir.

I was undertaking to say and I’m sorry if I didn’t make it clear that the Commission relied, rolled up on a comparison of the loss ratios and said that the loss here is no greater or not substantially greater than in other cases in which we have ordered divestment.

It said nothing about what happened after the divestment.

Justice Abe Fortas: I see.

Mr. John R. Quarles: And I have the feeling that here, the Commission figured that this was controlled by the president and have a great conclusion, it thought unnecessary to examine the record and formulate its own findings and opinion with the same care that it normally exercises.

And as a result of that, the findings and opinion contains so many inconsistencies omissions of essential findings and reasons and mistakes of fact that they cannot support a divestment order.

This really is the only theory on which I’ve been able to understand the action of the Commission in this case.

The Commission’s briefs and argument of counsel have been directed very largely a discrediting severance studies in general and Ebasco report in particular.

And at the same time undertaking thereby to justify the Commission’s reliance on his own general information and expertise instead of addressing itself to the specifics of the case before it thus at page 17 of their brief, they say, “We believe that given the highly conjectural nature of the predictions involved, the Commission must be guided by its knowledge of other public utility systems and its experience with successfully accomplished divestitures.”

The briefs do not answer the serious deficiencies in the findings and opinion which I detailed and I think adequately documented in our brief.

Justice Abe Fortas: Did Ebasco make some assumptions as to what would happen to the volume of gas company business after the divestiture?

Mr. John R. Quarles: I think it’s fair to say that they assume that there would be no change in the volume of business as a mere result of the divestiture.

There was evidence --

Justice Abe Fortas: Did the Commission disagree with that?

Mr. John R. Quarles: No indication that it disagreed with that except the very vague reference to the fact that there might be benefits from separation.

There was ample evidence by both the Ebasco witnesses, the company witnesses and the chairman of the Massachusetts Department of Public Utilities that the gas companies were being operated entirely as if they were independent and that their business was in no way being handicap by being related to the electric company serving the same territories.

Justice Abe Fortas: Sometimes as if there’s a long stretch, isn’t it Mr. Quarles.

Mr. John R. Quarles: It can be a long stretch but there is was accumulative evidence here but it was short stretched.

Much of the confusion in this case, I think stems from the fact that the Commission completely fail to deal with one of the three principal issues that it posed in the order of notice initiating the hearings and that was a status of these gas companies.

Now, our brother has referred to it as the gas system.

They are the eight separate companies whether or not they constitute an integrated system was one of the three principal issues.

On that, the Commission has not taken a position.

It has stated that it was concededly a separate independent system or could be, and the counsel in successive proceeding -- parts of this proceeding has given different explanation of why the one that’s given today is that the Commission’s action was stated to be an expressed reliance on the staff’s concession.

And what the findings and opinions say on this is that the companies concededly constitute a single system.

I read that to mean that the Commission was making the concession.

Certainly, the staff is always recognized throughout these proceedings.

It did have no authority to make any concession of this kind and the part of this that it went was to say that it would recommend a favorable finding to the Commission.

The Commission itself has repeatedly held that it will not accept the staff concession as a basis even for its own determination whether there must be evidence and findings to support it.

In this very case in the earlier phases, dealing with the electric companies when the question was identical, the Commission came out with elaborate findings and opinion and an order and even in this phase of the case with respect to the two other qualities B and C, although the staff had agreed that there was no question, the Commission thought it necessary to give the explanation and to make a formal finding.

It’s only under Clause A that there is no finding that is still unexplained and totally unprecedented in the Commission’s brief.

The Commission stated as Mr. Friedman has mentioned two alternative grounds for the divestiture.

One that the respondents have not adequately proved a loss of a million one as claimed, the other that even if proved, it would not be deemed substantial.

Now, with respect to the first ground, the Commission bases its action entirely on a rejection of the Ebasco report and the rejection of the testimony given by the Department of Public Utilities.

So the Ebasco report itself and the Commission’s treatment of it become crucial in this case.

First, let me say that the Commission for all the suggested infirmities, the Commission routinely requires a severance study and regularly relies on it.

Of course a severance study doesn’t purport to have mathematical exactitude.

But it has to be expressed in terms of dollars and cents as a starting point before you can determine whether the losses are to be deemed substantial.

You must determine what the losses are and the Ebasco report was for that purpose.

It was prepared by a team of highly qualified experts, independent consulting engineers who have had according to the Commission’s record wide experience in the utilities field.

They and the senior officers of NEES were working on this intensively for about a year.

The result came out as the report that has already been referred to.

That report was presented and explained with pens taken care and a long series of public hearings.

The staff took about 12 months to study the report in the related evidence and during that time, they requested and received quite a lot of additional material from the company.

At the end, the hearings where reconvened, the Ebasco witnesses were recalled were so objected to days of searching cross-examination that was frankly directed at discovering any kind of weaknesses in the report.

Anyone reading a transcript of the cross-examination of those witnesses, if found to be impressed as the Court of Appeals was by the wide knowledge of the utility field and the detailed and specific knowledge of the NEES situation that was indicated by these witnesses.

The findings and opinion and the brief both refer again and again to these serious deficiencies.

The inadequacies and a number of material aspects, the unexplained anomalies, and other things of that kind describing the so-called effects as if by a reputation you make it true but the findings and opinion actually identified as suspect only to relatively minor items in this whole massive report.

The petitioner undertakes the liabilities as merely examples of significant deficiencies resulting from the Commission having selected two communities as a test but that is not what the findings and opinion says nor is it consistent with the record of the hearing.

One of the two alleged deficiencies related to the possible use of a combined billing arrangement for the gas companies after separation.

And I think that the Commission’s handling of this in the findings and opinion pretty well indicates how little attention the Commission really gave this case.

First of all, it said that the respondents had not satisfactorily explained why combined billing couldn’t be used as a matter of economy and then it said that Ebasco had not even considered this as a possible economical means, neither those statements is correct.

The record on this is perfectly clear and explicit.

It was examined by the Court of Appeals and it’s summarized in the first opinion of the Court of Appeals.

Two Ebasco witnesses and the head of the NEES gas division testified expressly on the point.

They were cross-examined at length.

The evidence that they gave makes it perfectly clear that this possibility was explored and was rejected because they deemed not economical and undesirable for other reasons as well.

Now, whether their conclusions are accepted or not isn’t the point.

The point is that this shows that they gave a consideration and the fact that the findings and opinions states that no consideration was given to it or rather suggest that the findings and opinion proceeded without reference to the record.

The Commission’s statement of the other item was equally superficial but as pointed out by Mr. Friedman, it is too detailed go into a discussion that’s treated in both briefs.

Neither of these criticisms involved enough money to make any substantial difference in the result.

It is suggested, however, that they impair the credibility of the rights.

I suggest to you that the nature of the criticisms was not such as in anyway to cast out on the rest of the report.

It was a difference of opinion as to allocation of charges and items of that kind.

The Commission’s alternative ground for its decision was that the loss of a million one even if proved would not warn the attention of the gas companies when compared with the losses on the basis of which prior divestments had been ordered.

On reaching this result, I first of all note that the Commission looked only at the abstract amount of the loss and not at the consequences.

My brother suggested --

Justice Abe Fortas: What is it?

I beg your pardon.

To what is that relate?

What is the basis?

A million two did you say?

Mr. John R. Quarles: A million one hundred thousand dollars.

Justice Abe Fortas: A million and one and now, what does that relate to?

What is the gross revenue of that --

Mr. John R. Quarles: The gross revenue is about $22 million.

The net, however, comes down to this being approximately 30% of the net available for security holders.

It is a ratio that is higher than any of the previous cases and even if we take into account the cases in which the amounts were clearly pulled out of the sky with no real evidence to support.

Justice Abe Fortas: What you’re saying is that if I correctly understand you that the Ebasco study yielded the conclusion that after divestiture, the amount available for the stockholders from the operations of these gas properties wouldn’t be reduced by 30%.

Mr. John R. Quarles: Reduced by 30%, that is correct and would bring the rate of return far below any that would be such as to attract new capital and according to the testimony of the chairman of Massachusetts Department of Public Utilities would probably result in the need for rate increases.

Justice Abe Fortas: But did you said that that did not take into account the possibility of an -- of an increase business as a result of the divestiture?

Mr. John R. Quarles: That is correct.

We assume that there would be no increase business and there was ample evidence in the record to that effect.

Now, the Commission as I say in reaching its result was looking only at the amount in terms of ratio, yes, but not at its effect.

And actually, in the present position, the petitioner is saying that it shouldn’t be expected to look at the effect because that would require using its own phrase, “wresting with uncertainties” and would involving delays and timing consuming proceedings.

Now, whatever inconvenience may be involved, it seems to me, perfectly evident that the serious impairment test that this Court has prescribed requires the Commission to consider the effect of prospective losses in the light of the new situation, not merely the amount of the loss in the abstract.

The Commission and the courts have regularly taken that view and even in this case in stating the applicable statutory standards.

The findings and opinion quoted from the Circuit Court’s decision in the Engineers case, substantial economies must mean important economies.

The required importance must relate to the healthful continuing business and service of the freed utility.

Again, the Commission by its own admission here decided this case solely on the basis of precedent without any inquiry concerning the comparability of the circumstances.

The counsel now attempt to reference to the prior cases merely is indicating consistency in the dealings but that wasn’t the way the findings and opinion treated it.

The findings and opinion said in effect, “this is not substantial when we compare it with other divestment cases.”

And when the respondents of the Massachusetts Department of Public Utilities presented evidence showing that the situations were different and that losses here would have a more serious effect in corresponding dollar amount of losses to companies near the source of natural gas and who therefore had a margin, they rejected that evidence on the ground that other companies in Massachusetts were getting along all right.

And throughout the brief and the reply brief, there is heavy reliance on the assumed prosperity of the other comparable gas companies in Massachusetts.

First, there is nothing to show that they’re comparable except that they’re both in Massachusetts but --

Chief Justice Earl Warren: I suppose I won’t be comparable so far as the transportation of gas --

Mr. John R. Quarles: That is correct sir.

They would have that same handicap but the evidence was -- there was a great deal of evidence of difference in the type of territory served, the franchise area, the chairman of the Department of Public Utilities particularly emphasis that.

The second point is that here, it is assumed that they are prospering the evidence was not, would not support that finding.

There was evidence of some business difficulty of a single case of bankruptcy.

There was -- even the findings and opinion went no further than to say that the other companies have been able to continue operations and apparently earned a satisfactory return which is quite along crasser from the finding that they are successful.

Chief Justice Earl Warren: They did quote the returns, didn’t they?

Mr. John R. Quarles: They -- there was reporting of the rate of return and the comparison and some indication of the rate of return going down 58 to 59 but the rate of return at a moment in time for a single year or for two years is to a measure of the successful company.

You must know something about the kind of service that they’re rendering, the extent to which they’re maintaining their properties, the divert maintenance alone can maintain a rate of return for several years.

So we come then to the question of the Commission relying on seven precedents which the Court of Appeals referred to as other cases in other times and other places.

They were all cases of divestment, of companies much closer to the source of supply and that is significant.

But the more important thing is that not one of those seven cases on which the Commission based its opinion is really in point or really supports the conclusion.

And five of them, they did not say that it was not substantial but rather they said that the amount wasn’t shown or was improved.

Apparently, the petitioner gets some comfort or having admitted that they were right on the other two in saying that the Commission had based the decision on the amount not being substantial.

That’s right.

But the amounts in those other two cases were so much smaller than the amounts in our case that they appear to have no particular significance.

Justice Abe Fortas: Were so much what?

Mr. John R. Quarles: So much smaller, the amount of the loss in the two cases where the Commission did base it on the amount.

Justice Abe Fortas: How about the gross revenue?

How about the base?

Mr. John R. Quarles: The -- I was referring to the ration of the loss to their income to the various --

Justice Abe Fortas: You mean there was less than 30?

Mr. John R. Quarles: Or it was down to about 5% or 6%.

Justice Abe Fortas: 5% or 6% of the amount available for a stockholder.

Mr. John R. Quarles: As compared with the 30% in our case so that we, in our brief and in our Appendix for the brief, had indicated that those two cases have no particular significance.

Now, I do want to get to --

Justice Byron R. White: Except that I would suppose that even if the -- even if the Commission were wrong in saying the loss ratios were comparable, the cases have some significance in the sense that there were some companies that were split off and were going to be independent and they may be of comparable size and comparable situation.

Mr. John R. Quarles: There’s no where -- nothing to indicate that they are of comparable situation.

There was evidence that they were not of comparable situation because it was closer to the gas fields and therefore had a much wider margin of profit and could raise their rates if need be.

Whereas here at the end of the line, the grievous link from the gas fields of any gas distribution systems, they were under the handicap and the Commission --

Justice Byron R. White: Now, if the Commission comes up and says we’re going to order this divestiture and that you met your burden of proof because here are ten companies who in our judgment are comparable enough to the company we have before us now to -- and these companies are successful, they can exist and they’re comparable enough that we think you care.

Do you think the Commission must go farther than that?

Mr. John R. Quarles: I do indeed sir.

I think that before the Commission can —-

Justice Byron R. White: Write down and say why they’re comparable and why they aren’t comparable?

Mr. John R. Quarles: No sir but I think that before the Commission can make that kind of an assumption, it must have more than appears in this record or so far as we know is in the files of the Commission even as to what is the condition of these other companies.

Are they in effect prosperous companies or are they not?

Now, the question was raised as to the --

Justice Byron R. White: And you think that -- do you think it would be fatal to the Commission’s case if there have to be a rate increase for this company does exist?

Mr. John R. Quarles: No sir.

I don’t think it would be fatal to it.

I think that’s one of the factors that we need to be taken into account and there was evidence that any rate increase might very well start as paralleled that would be disastrous because of the fact that they were already according to the evidence and the record here, they were already operating on such a narrow margin or as the court below said on I think the term used was a small cushion.

Justice Byron R. White: Have there been any -- any evidence to this case to gas system competed with the electrical system while that was under one management?

Mr. John R. Quarles: The evidence was to the contrary.

The evidence was that beginning back in 1955 I believe or at about that time, the company had made a very thorough division of activities and had separated.

Justice Byron R. White: Even though they were territorial overlap?

Mr. John R. Quarles: Oh yes and the territorial overlap was one of the things that give us the largest amount of savings.

It was reference to the former action on the case that was here before, it will be remembered that the only question was the meaning of the phrase substantial economy or loss substantial economy.

At that time, the Commission took the position that the only way the policy of the Act could be given effect as a practical matter was by incorporating it into the test, making a very stringent test that this Court approved.

The test is stringent.

Now, we suggest to you that having given effect to the statute in that way, if it is desirable to use this assumed benefit of free competition to offset proven losses, there must be some showing that some practical benefit will come from that.

Justice Byron R. White: Well, is this case over if you win here?

Mr. John R. Quarles: No sir.

If we -- if we win in this --

Justice Byron R. White: You know on your approach is that they have not done a decent job of articulating the basis for their decision and some other cases where this Court is reversed on that basis or has made that kind of adjustment.

The case has been remanded.

Mr. John R. Quarles: May I suggest that our position is merely a question of particulation.

We go to the substance of the Commission not having really come to grips with this case, not having examining the facts of it on their own merit --

Justice Byron R. White: But again, what if you win?

What will happen to the case?

What if you win here then the judgment that the Court of Appeals has affirmed?

Mr. John R. Quarles: It then goes back to the Commission for reexamination to determine whether or not within the instructions from this Court or the Circuit Court, it is possible for them to give an adequate answer, if not then further hearings or further review of the evidence.

This does not end the case.

Thank you.

Chief Justice Earl Warren: Mr. Friedman.

Rebuttal of Daniel M. Friedman

Mr. Daniel M. Friedman: Mr. Chief Justice and may it please the Court.

I think that most of the point that Mr. Quarles has made have been dealt within our brief and replied brief but I would like to refer to certain specific points that he made.

First, on the question of whether there was like -- there were likely to be offsetting benefits.

If the electric and the gas system to have separated from common management, I would like to refer to pages 20 and 21 of the Appendix in the Commission’s report where the Commission said, the basic competitive position that exist between gas and electric utility service within the same locality is affected by such vital management decisions, as the amount of funds to be raised for or allocated to the expansion or promotion of each type of service.

That’s in the middle of page 20 and then over about the middle of page 21, the Commission said on the basis of the facts presented in this case, we cannot conclude that a management solely interested in and devoted to the gas operations would not be able to advance them more effectively.

Now, the question is also been raised as to what happened to some of these prior systems or the divested.

I would like to invite the Court’s attention in footnote 24 at page 18 of the appendix where the Commission pointed out that the NEES gas system is substantially larger than systems we have divested in prior cases and then it goes on to say sighting two of its decisions.

We found that several of those systems in turn were larger than companies that had demonstrated conclusively their ability to operate effectively free upholding company control.

On the question is to whether this divested system would have the ability to finance itself which they’re concerned about.

This testimony which I didn’t like to invite the Court’s attention to it refer to footnote 5 of our reply brief at page 13 in which Mr. Hanson, the Chief Financing and Accounting Officer of the NEES system said, he would expect they should be able to raise capital on a sound and economic basis.

If the gas companies were divested and created as a new system although they said probably its equity financing would be more costly than at the present time.

On combined billing which so much is made of that the Commission have no basis rejecting the claim on combined billing.

We again have had a long footnote on page 2, footnote 2 and page 8 of our brief in which we pointed out that Ebasco had made no study of combined billing that their witness testified that it was his view the combined billing here would not provide any advantages to the gas system.

And then he was asked, well if he were requested for an expert opinion by the management of the new independent gas system would he so advised and he said he was sorry.

He couldn’t answer that question without making the study.

And finally, I just like to refer again to the opinion of this Court when the case was here before in which Mr. Quarles in answer to Mr. Justice Fortas’ opinion, question, indicated that one of the problems would be as if these expenses took place, there will be less money available for the stockholder’s dividends and I think the answer to that is given by Mr. Justice Douglas toward the end of his opinion when he spoke about the offsetting benefits of competition from electric and gas, and said that was a matter for Commission expertise on the total competitive situation not merely on a prediction whether for example a gas company in a holding company system would make more for investors than a gas company converted into an independent regime and that’s what we think on this record that the Commission was required to deal to justify in saying that this gas company should be converted into an independent regime.

Justice Byron R. White: Mr. Quarles mentioned the matter of no finding about the gas companies being an integrated system.

That isn’t the issue in this case.

Mr. Daniel M. Friedman: No.

That -- we’ve dealt with that in our brief.

They have contended that’s an --

Justice Byron R. White: The Court of Appeals did -- the Court of Appeals must have dealt with that.

Mr. Daniel M. Friedman: No.

The Court of Appeals did not rest on it.

There is a claim that the Commission is being inconsistent in accepting the Ebasco study for purposes of deciding it was an integrated gas system but have not accepting it for these purposes what the Commission did.

The staff conceded it was an integrated gas system to get that issue out of the case so that the Commission could reach the real issue in the case and we’ve dealt with it in our reply brief at some length explaining why we think there was no inconsistency in saying that the Commission did not rely as we -- on this study as a basis for that determination.

Thank you.